Time Value of Money TVMKey Concepts 1 TVM

Time Value of Money (TVM)—Key Concepts 1. TVM rule—never compare dollars that are from different time periods; only compare dollars that are from the same future period or are from the present period. 2. Future value (FV)—add interest to a current amount for a particular number of future time periods; multiply each period’s beginning amount by (1 + r). 3. Present value (PV)—take interest out of a FV amount for the number of future periods it earned interest; divide each period’s ending amount by (1 + r). MUMA COLLEGE OF BUSINESS

Time Value of Money (TVM)—Key Concepts 4. Cash flow patterns a. Lump-sum amount—a single payment, either in the current period or at some future point in time. b. Annuity—a series of equal payments over equal time periods i. Ordinary annuity—annuity payment at the end of the period. ii. Annuity due—annuity payment at the beginning of the period. c. Uneven cash flows—a series of cash flows that are not all equal, have differing periods between payments, or both conditions exist. 5. Intra-year interest compounding—interest is paid more than once during the year. MUMA COLLEGE OF BUSINESS

Time Value of Money (TVM)—Key Concepts 6. Effective annual rate (r. EAR) versus annual percentage rate (APR) a. r. EAR is the rate that is earned when compounding is taken into consideration. b. APR is the simple, or stated, rate of return that does not consider the effects of compounding. c. r. EAR = APR only when compounding occurs once per year; when interest is paid more than one per year, r. EAR > APR. 7. Amortized loan—equal loan payments that consist of two components: a. Interest owed on the loan since the last payment; this portion decreases as a greater amount of the debt is repaid. b. Partial repayment of the debt; this portion increases as less interest is paid. MUMA COLLEGE OF BUSINESS